9) Breakdown of Gibson’s Paradox: CPI index v. interest rates since 1968 250
200
150
100
50 0
US CPI index (1982-84=100) US 10-yr Treasury yield (%)
Source: ADM ISI, Bloomberg 10) End of Gibson’s Paradox: US CPI v. 10-yr Treasury yield (since 1968)
50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% -5%
US CPI (%) US 10-yr Treasury yield (%)
Source: ADM ISI, Bloomberg
11) S&P 500 v. Commodity Prices (since 2016) S&P 500
2350 2300 2250 2200 2150 2100 2050 2000 1950 1900 1850 1800
Continuous Commodity Index
450 440 430 420 410 400 390 380 370 360 350
Source: ADM ISI, Bloomberg
However, Gibson’s Paradox broke down with the collapse of Bretton Woods as we transited from a Gold Exchange Standard into today’s free floating system. Here is the chart of the consumer price level and interest rates since 1968, the year which saw the collapse of the London Gold Pool, and prefaced Bretton Wood’s demise (see Chart 9).
Jumping the shark… However, the next chart shows that, while Gibson’s Paradox broke down, the correlation between interest rates and prices shifted from the level of prices to its first derivative, i.e. to the rate of inflation itself (see Chart 10).
27 | ADMISI - The Ghost In The Machine | January/February 2017
16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0
16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0
We suspect that this is the result of the “hyper” strategies of central banks in terms of “hyper-credit creation” and the loss of a monetary “anchor” in terms of gold.
It’s interesting to look back to the inflationary spike during 1976-80 and see how interest rates lagged the rise in inflation for most of that period. Fast forwarding to today, it also implies a monumental challenge facing policymakers if, as many people believe, we are transitioning to a world of higher inflation and interest rates.
In 1976-80, US total debt/GDP in the US was 160-170% compared to about 320% today. China – another huge debt bubble - is approaching 300%.
Going forward, a rise in inflation would put policymakers between the proverbial rock and hard place. Allowing rates to rise sufficiently quickly to temper rising inflation would likely crash an over- indebted economy. Unfortunately, staying too far “behind the curve” risks runaway inflation. More likely, we could see some kind of messy compromise with bonds moving into a bear market (but not a catastrophic one for the time being) and higher (but not runaway) rates of inflation.
This is probably the best scenario for equity markets that we can hope for, where they benefit from a re- allocation of capital away from the bond markets. In a financial system with no anchor in terms of value, e.g. a Gold Standard, the basis for valuation is relative.
Earlier we showed how commodity prices bottomed in early 2016. Since then, there has been a generally close correlation between the S&P 500 and CPI… (see Chart 11) ...which raises the question to what degree equities are increasingly the inflation hedge of choice when the world is “inflating” in the broadest sense?
If physical demand overcomes the control exerted by paper gold and silver substitutes, the world class inflation hedges will come to the fore.
Paul Mylchreest E:
paul.mylchreest@
admisi.com T: +44(0) 20 7716 8257
Jan 16 Feb 16 Mar 16 Apr 16 May 16 Jun 16 Jul 16 Aug 16 Sep 16 Oct 16 Nov 16 Dec 16 Jan 17 Feb 17
1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
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